The largest and most far-reaching reform of U.S. financial services regulation since the Great Depression should clear its final hurdles this week, with Senate passage now assured. But the impact of the Dodd-Frank bill—named for its primary sponsors, Sen. Christopher Dodd (D-Conn.) and Rep. Barney Frank (D-Mass.)—especially on the alternative investments industry, remains an open question.

Weighing in at over 2,300 pages, the proposed legislation—which is expected to land on President Barack Obama's desk tomorrow, after three Republican senators from New England agreed to support the compromise bill—will touch most aspects of the financial markets, including the question of banks “too big to fail,” the riskier activities of commercial banks via the Volcker rule, over-the-counter derivatives trading and more.

Hedge funds appear to have escaped the cudgel of tougher regulation, with a provision requiring registration with the Securities and Exchange Commission the only new rule that specifically applies to the industry. But evaluating the possible impact of the new rules is difficult at this stage, says Jack McDonald, president and CEO of prime broker and hedge fund administrator Conifer Group.

“I think part of it is the uncertainty around what it’s actually going to mean in the end,” he says. “I think the question is, will the bark be worse than the actual bite?"

As the bill stands, hedge funds would face greater scrutiny, and those with more than $150 million in assets under management would have to register with the SEC (55% of hedge funds are already registered with the regulator).

"The exemption that most people rely on now is the less-than-15-clients exception, and that is being removed from the Advisors Act," explains Patrick Shea, managing director of HedgeOp Compliance, which advises fund managers on compliance issues. Now, managers who hope to grow larger than $150 million know they will have to deal with the registration process at some point, he says.

Shea has already seen an increase in the number of requests from fund managers for the compliance firm's services. But many managers, under pressure from their investors, are already voluntarily conforming to the standards of the Registered Investment Advisors Act, he adds, so the job of actually registering won't be so onerous for them.

Can Regulators' Handle Registration?

Former SEC Chairman Harvey Pitt, who advises hedge funds Millennium Management and Paulson & Co. on compliance issues, is no fan of the new regulations. "The bill sets the SEC up for failure,” he wrote in the Daily Beast today, giving the already underfunded and overstretched SEC more responsibilities.

"In particular, the SEC won’t be able to inspect tens of thousands of new firms it will oversee—or pay to get the kind of expertise to compete with the private sector," he wrote.

Marc LoPresti, a partner at law firm Tagliaferro & LoPresti, which caters to the investment management industry, shares this concern.

"So much of this bill just requires further rule-making and further review, and the biggest impact is what this is going to do in terms of the workload of the SEC," says LoPresti. "That is a scary thing, because I don't think that they are being provided with sufficient additional resources to tackle this unbelievable breadth of new rule-making while they are also in this stepped-up enforcement environment."

But while many critics oppose the registration requirement or question regulators' ability to enforce the rules, Conifer's McDonald says he understands the measure.

"A lot of the proposed registration requirements are there to protect individual and institutional investors and, I think, in and of itself, that’s a good thing,” he says. “Whether or not funds need to actually register with the SEC to bring about greater investor protection is another thing, but I do think the vast majority of hedge funds are good businesspeople that have nothing to hide. Certain aspects of regulation can be a positive in terms of instilling best practices in the industry and I think most [hedge funds] would already meet the threshold.”

McDonald says an increasing percentage of the funds Conifer deals with are registered, and points out that many are registered to do business in California, which already has in place regulations similar to those proposed in the bill. On the other hand, he fears the necessity to register could be a further impediment to smaller startup funds. The variable, he says, is what additional costs registration will entail. If these prove high—as those associated with the 2002 Sarbanes-Oxley act did—they could have a negative effect on the industry.

Watered-Down Volker Rule

Another aspect of the regulations that will affect the hedge fund market is the watered-down Volker rule, which was originally designed to keep banks from putting any of their own money in hedge funds and private equity funds, or to trade like them with proprietary trading desks. Under the version that survived the House of Representatives-Senate conference committee, bank holding companies will be permitted to invest up to 3% of their capital in alternative investment funds.

Conifer's McDonald, for one, is skeptical that such a de minimis exemption is required.

“You would mitigate concerns about banks competing with their customers” by booting banks out of the alternative investments space, he says. On the other hand, he doesn’t have a problem with banks having distinct and separate asset management arms, including those with hedge fund units.

In general, McDonald believes the point of the new regulations is to bring greater transparency to the financial sector, and he believes that’s a goal the alternative investments industry could achieve left to its own devices. “I think the industry is actually addressing that on its own,” he says, “Products are changing – you can see it in the evolution and growth of the market, in, for example, the growing use of separately-managed accounts.”

Now, they’ll have to address the issues in conjunction with regulators.

"Tomorrow, I think it finally moves through," Shea says of the reform bill.